At the height of the property bubble, California's giant pension fund, CalPERS, made a fateful decision: It aggressively poured money into real estate. As a result, today it's one of the biggest owners of undeveloped residential land in America.

Partly because of these investments, the California Public Employees' Retirement System is struggling to avoid one of its worst annual declines since its 1932 inception. CalPERS has lost almost a quarter of its assets since July 1, the start of the current fiscal year.

The problems come at a time of uncertainty for the nation's largest public pension fund, which had been without its top two executives for nearly half a year. CalPERS yesterday announced a new chief executive: Anne Stausboll, who has been serving as CalPERS interim chief investment officer.

CalPERS is warning California's cities, towns and schools that they might have to cough up more money to cover the retirement and other benefits that the fund provides for 1.6 million public workers. Some towns already are cutting municipal services, and at least one is partly blaming the CalPERS' fees.

CalPERS has said in recent weeks that it expects to report paper losses of 103 percent on its housing investments in the fiscal year ended June 30. That's because the retirement system invested not only its own money, but also billions of dollars of borrowed money that must be repaid even if the investment fails. In some deals, as much as 80 percent of the money invested by CalPERS was borrowed.

The latest wrinkle: To generate sorely needed cash, a troubled CalPERS venture known as LandSource Communities Development recently started the process of selling land during the worst property market in a generation. CalPERS could potentially lose nearly $1 billion on LandSource, a $2.5 billion deal completed early last year and one of the priciest U.S. residential-land transactions ever. LandSource, whose key asset is the last major tract of undeveloped land in Los Angeles County, is under bankruptcy-court protection.

With $239 billion in assets as of June, CalPERS' portfolio was bigger than the government-run funds of Russia, South Korea, Dubai and Chile combined. In recent years, CalPERS became much more aggressive than other pension funds in making nontraditional investments – real estate, foreign stocks, even forestland.

Unless CalPERS' returns bounce back by June, the fund says it expects that the rates it charges governments to participate in the pension could rise starting in 2010, leaving them with less money to spend on other services.

Alicia Munnell of the Center for Retirement Research, Boston College, says the economic slump probably will force other pension funds besides CalPERS to pass on the financial pain. “Even under the best-case scenario . . . taxpayers are still going to have to put more money into pension funds.”

CalPERS points out that its commercial properties, including a chunk of the Time Warner Center in New York, haven't been nearly as hard-hit as residential investments, which are valued at about $6 billion. Together, residential and commercial holdings total about one-tenth of the fund's overall $182.6 billion portfolio. Its real estate portfolio fell 14.4 percent for the 12 months ended in September, underperforming its benchmark, which rose 5.3 percent.

CalPERS stresses that it's a long-term investor and can earn back the declines in the future, just as it erased declines suffered in the dot-com bust a few years ago. “No one in the marketplace knew how swiftly the housing market would fall – not the Federal Reserve, not the Treasury,” said Ted Eliopoulos, head of CalPERS' real estate portfolio.

The fund has also added “checks and balances” on property-investment decisions, Eliopoulos said. “CalPERS has always attempted to learn from downturns,” he said.

The details of CalPERS' housing deals and the identities of some of the home builders it invested with are only starting to come to light. That's because investments often were made through ventures with opaque names such as Hearthstone Path of Growth Fund, and CalPERS doesn't detail many of their holdings.

CalPERS says its investments were done with “customary oversight” and were “appropriate for the asset class and typical the industry.”

In recent years, CalPERS invested in:

Three large parcels near Phoenix, one of the nation's hardest-hit property markets. Last month, CalPERS effectively walked away from one of the three, after having invested $140 million. On one of the others, to start earning a return, CalPERS' investment partner recently started selling groundwater from the property.

A massive block of land with room for about 8,000 units near the small town of Mountain House, the nation's most “underwater” housing market by one measure. (Nearly 90 percent of homeowners there owe more on their mortgages than their homes are worth, according to mortgage-research firm FirstAmerican Corelogic.) As of June 30, CalPERS valued the investment at negative $305 million, reflecting the fact that it has repaid borrowed money used in the deal.

About 10,000 acres near Jacksonville, Fla. The plan was to sell timber from the property, as well as residential lots. But as real estate collapses, it could take five years before the venture can start selling lots.

Just one particularly bad year for investments can have serious consequences for California governments in the retirement system. CalPERS recently estimated that if its declines for the current fiscal year are greater than 20 percent, it would trigger an increase of 2 percent to 5 percent of an employer's payroll.

Currently, the average employer-contribution rate for public agencies, including cities and counties, is 13 percent of payroll, CalPERS said. That rate is on the high side for state pension funds, industry analysts said. A 5 percent increase in California's rate would be the largest increase to hit public employers since the dot-com bust.

Any rate increases aren't a certainty, CalPERS says, because the fund could still earn back its declines.

Real estate losses aren't the primary reason CalPERS is taking a hit. Its biggest declines have been in the stock market: Its stock portfolio is down 41 percent so far this fiscal year.

CalPERS has targeted less money in bonds than the average public pension fund, according to CalPERS documents and an industry survey, while its allocation to private-equity investments and real estate deals is about double the average.

CalPERS got more aggressive in real estate amid the tech-stock sell-off of 2000-02. Its board decided to increase its investments in real estate and private equity, shifting some money out of safer, but lower-yielding, holdings such as bonds.

Robert Carlson, a former CalPERS board member who left the board earlier this year, said publicly at that time, “We believe taking no risk is the biggest risk you can take.”